We spoke to  a financial advisor to clarify who would benefit from whole life insurance policies, who wouldn’t, and what’s important to know going in

Dovid, a company executive, excelled in his career and constantly sought opportunities to rise up the management ladder. Once he started making significant money, he and his wife, Devora, sought the expertise of a financial advisor for guidance with growing and securing their wealth, numbering in the hundreds of thousands. They knew the basics — spend responsibly and save wisely — but investing was a bit foreign to them, as was tax planning and wealth management.

The financial advisor got to know them, exploring their financial goals, tolerance for risk, and investment knowledge. He helped them diversify their investment portfolio with multiple types of investments, max out contributions to retirement accounts, and explore various wealth-building and tax-planning strategies.

He also suggested that they consider permanent life insurance, such as whole life insurance, as an additional tool for securing their financial future.

The term whole life insurance is commonly bandied about, but often without a deeper understanding of how it works or what makes a good candidate for such a policy. Let’s examine several scenarios involving couples who purchased such whole life polices, contrasting the ones who made informed decisions with the others who made mistakes and could have secured their futures more wisely otherwise.

The Nuts and Bolts

Unlike term insurance, which lasts for a specific number of years (the “term”), whole life was designed to last an entire (whole) life, with the specified beneficiaries receiving a death benefit when the insured passes away.

Whole life insurance, which is part of the “permanent product” life insurance sphere like universal life, is always more expensive than term insurance because it offers an investment component called the “cash value” account. This investment component grows tax-free throughout one’s lifetime.

Many whole life insurance policies have two components: the guarantees promised by the insurance company and the “non-guaranteed” features that are included in the policy as enhancements.

What are the guaranteed components of a whole life policy? These typically include a guaranteed death benefit and the fixed premiums that remain stable over time regardless of the insured’s health status.

Let’s meet Eli. At the age of 50, he bought a whole life insurance policy that provided his beneficiaries (wife and kids) with a guaranteed $1 million death benefit upon his death. In return, he had to pay an annual premium of $25,000 per year.

But whole life insurance policies have one more guaranteed component: a cash value account that grows at a guaranteed minimum rate. What does Eli’s cash value look like? By age 80, in addition to having a $1 million guaranteed death benefit, he will also have $607,720 in his guaranteed cash value account that will have accumulated over time.

What can Eli do with this cash value account? The cash value, which grows tax-free (you aren’t taxed on the growth), can be accessed either as a withdrawal or as collateral for a loan (more about loans later on). If you withdraw money from your cash value in the form of a withdrawal, it’s tax-free, and you don’t pay taxes on it until the withdrawal exceeds the amount of premiums paid into the policy. In other words, if you take out $25,000 as a withdrawal and you paid $20,000 in premiums, you may be taxed on the $5,000. Withdrawals can also negatively affect the policy’s death benefit.

Unlocking the Potential: Exploring the Non-guaranteed Elements

As long as Eli pays his scheduled premiums, his cash value grows and eventually his beneficiaries will get the $1 million death benefit. Now, while the cash value is guaranteed to grow at a prestated minimum interest rate, there’s also a chance that it will grow even more than that. This is called the “non-guaranteed cash value.”

How does that work? The insurance company manages its own investments, and the performance of these investments determines the returns passed on to policyholders through their non-guaranteed cash value account.

While Eli’s guaranteed cash value at age 80 is $607,720, the non-guaranteed cash value account is greater because it’s benefiting from receiving dividends. By age 80, his non-guaranteed cash value is $1,273,686. Sounds good, right? However, Eli needs to be careful because if he changes the amount of a premium payment or misses it all together (or takes a loan or a withdrawal), his cash value can take a hit.